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Federal regulators have essentially put the kibosh on nationwide lending programs linked to home energy efficiency retrofits, encouraging state and local governments to rethink “significant safety and soundness concerns.”

Federally controlled mortgage lenders Fannie Mae and Freddie Mac told lenders back in May that they would refuse loans associated with the programs, known as PACE and backed by stimulus funds doled out by the Obama administration.

The costs show up as an annual surcharge on homeowners’ property taxes. But in most states that have authorized the programs, the senior lien is attached to the property and takes precedence over existing mortgages in the case of default and foreclosure.

Government officials, especially in California, have touted the programs as a job-sparking endeavor to cut greenhouse gas emissions, and insisted that PACE's financial criteria are safe. But in a "fragile housing finance market," federal regulators don't seem too keen on the risk.

At the housing finance agency's direction, Fannie and Freddie will tighten borrowers' debt-to-income ratios to account for future PACE loans. They will also adjust the loan-to-value ratios for borrowers living in jurisdictions where PACE is available, making it potentially difficult for even nonparticipants to land mortgages.

However, lenders can waive the ban for homeowners who already have energy loans.

Regulators also asked state and local governments to put the programs on hold, claiming that first liens for PACE loans were a departure from traditional mortgage lending standards and present “unusual and difficult risk management challenges” for lenders, servicers and mortgage securities investors.

PACE tampers with the valuations for mortgage-backed securities and relies on collateral-based lending instead of the loan recipient’s ability to pay, the federal agency said.

Also, it’s debatable whether the program can actually “produce meaningful reductions in energy consumption,” the agency said. Underwriting, consumer protection and energy retrofit standards are still being developed, regulators said.

The battle over PACE has kicked up a round of protests from officials and lawmakers.

Gov. Arnold Schwarzenegger’s office called the federal regulators’ decision a “bureaucratic breakdown” that “threatens one of California’s most promising new engines of job creation in this struggling economy,” especially in the construction industry.

“This decision not only puts at risk millions of dollars of Recovery Act funds but sends a message to local governments and private businesses that energy independence is not a priority,” Schwarzenegger said in a statement Tuesday.